Policy Seminar With Adrien Auclert

>> John: Thanks so much for coming, Adrien, we appreciate it. This is the economic policy working group. We got some people on the screen over there who are anxiously listening and they'll jump in at the appropriate time. But-

>> Speaker 5: When is the appropriate time?

>> John: Now. No, you wanna talk for a few minutes.

Beautiful slides, the slides will be shown on the screen. I have a copy myself, but you'll be able to talk through those. That'd be great, but thanks so much. The title is managing an energy shock. Speaking of shocks, fiscal and monetary policy. So go ahead, Adrien.

>> Adrien Auclert: Thanks so much, John.

So it's great to be here, and feel free to interrupt as I go.

>> John: We don't have to wait seven minutes.

>> Adrien Auclert: You don't have to wait seven minutes if you want to ask a question. And so the question that motivates this paper is that of how rising energy prices are affecting the economies of energy importers.

So this is obviously motivated by the current situation, especially in Europe, in the face of these large energy prices that we've seen. And so if you ask economists, what are the effects of rising energy prices? There's kind of two typical answers. One is that it's a negative shock to aggregate supply.

So because energy prices are rising, firms substitute away from energy. That leads them to use less energy and leads to an increase in costs. And so that can look like a productivity decline. And another effect you hear a lot about is that it's a negative shock to aggregate demand because these rising energy prices are pulling down on real incomes.

And because of this, that might lead households to cut back on spending.

>> John: If you measure productivity as TFP, there's no-

>> Adrien Auclert: Correct, yes, yeah, so.

>> John: When this became a big deal in the 70s, I had to say over and over that factor prices don't change production functions.

 

>> Adrien Auclert: Yeah, so.

>> John: Movie it along.

>> Adrien Auclert: So my paper is just going to be about the second question. But I will point out this series of papers by David Baqaee and co-authors, including a policy paper by Bachmann and others that have tackled this question. And even though this is not really their main bottom line, if you read through the lines of that paper, it basically says you don't get an effect on GDP at all from rising energy prices if you're measuring GDP correctly, okay?

So we're actually not going to go into this at all.

>> Speaker 4: This discussion kind of rule, they shut down factories for lack of certain fuels and so on.

>> Adrien Auclert: Mm-hm.

>> Speaker 4: That's a supply shock. May not be a productivity shock, but it's a supply shock of sorts.

>> Adrien Auclert: Yeah, so.

 

>> Speaker 4: How does that fit into this discussion?

>> Adrien Auclert: Well, so you'll see how I model the shock. So I want to kind of isolate the effects on aggregate demand. So the energy is just going to be used by consumers. They're going to just consume energy, and that's going to be imported directly and energy won't be used in production.

I can talk about what happens if energy is used in production also. And then there's questions of how you want to measure output, gross output, or gross national expenditures, or GDP and so on. But I want to focus on the second point because the first one's been talked about in the literature.

So I think that there's less value added in revisiting this. And the starting point of our paper is to ask, one, is it true that a rising energy prices actually create a negative shock to aggregate demand? And to the extent that it does, what is the role of monetary and fiscal policy in this situation, okay?

So, the starting point we'll have is we'll take a completely standard open economy, New Keynesian model. And we'll say, if it's a representative agent model, actually, it's not obvious that it's a negative shock to aggregate demand. It's typically more a positive shock to demand because remember, this is an energy importer, there's rising energy prices.

So consumers tend to substitute away from energy that's imported towards domestic goods that are produced domestically, say, services. And so that actually tends to raise domestic demand. And the magnitude of that effect is governed by a certain elasticity of substitution, which is governing the extent to which household substitute away from energy towards domestic goods.

And so that's one effect, which is an expenditure. Switching effect on the other hand, there's an income effect, but the income effect doesn't affect demand much, if at all. Why not much? Well, so first at all, because in most of these models, there is an international risk sharing condition, so households are insured against these types of shocks.

So in a complete market type of model, there would be no effect on demand. Now, in an incomplete market type model, there would be an effect on demand, but that effect would tend to be small because households have low marginal capacities to consume. So the decline in income doesn't really affect their consumption very much, right?

So then you're left with a type of model that says, in the face of rising energy prices, you actually have a boom, a demand boom, and there's little trade off for monetary policy. You want to raise interest rates to curb that boom and also to limit the inflationary effects.

So we think that that's kind of a nonstarter for thinking about the current European situation. And instead, we're gonna revisit this by embedding heterogeneous agents into this New Keynesian small open economy type of framework. And the main difference that this will bring is the fact that households in the model will have much larger marginal capacities to consume.

So the decline in real income will affect consumption a lot more. And so when the elasticity of substitution is low, there's still this substitution effect, substitution towards domestic goods. But when the elasticity of substitution is low, which we think is realistic in the short run for thinking about energy, this effect is going to dominate.

And so we'll get a decline in both consumption and demand. So that's going to be a negative demand shock. And in fact, that shock can be stagflationary under a condition that I'll talk about. And that situation, you get a recession, imported inflation, but also a wage price spiral.

So domestically, then nominal wages are rising, and so you get nominal wage inflation. So we think that that's kind of a more natural framework to start thinking about what monetary and fiscal policy would wanna do in this situation. So we're gonna think about both. So for monetary policy, we'll point out that it's very hard to influence energy prices when you're using monetary policy in isolation.

So if you're a really small economy and you're, say, tightening monetary policy, you're not affecting energy demand for the world as a whole. And so all you can do is you can appreciate your exchange rate, so you can mitigate the effect on domestic energy prices, but you can't affect the source of the problem, which is that demand is too high relative to supply.

But this is a situation where monetary policy coordination can be very useful. So if big countries tighten together, then they're able to curb energy demand for the world as a whole. So it's like a positive externality type situation where you can be much more effective at dealing with the energy shock if monetary policy is acting or central banks are tightening together.

 

>> Speaker 5: So it's the high MPC people who are key to this?

>> Adrien Auclert: The high MPC people are key to getting this process started. So the reason why the decline in real incomes affect demand in the first place is because you have high margin capacities to consume.

>> Speaker 5: It seems like it's hard to get this numerically realistic because the high MVC people have very low incomes, so they can't be.

 

>> Adrien Auclert: But they might be consuming a lot of energy. So I don't have that extension. But in my model, actually there's homothetic demand. But it's easy to have a model with non-homothetic demand where the poor consume more energy so they actually account for a disproportionate share of energy demand.

 

>> Speaker 4: There's a real calibration issue here. It seems like you'd want to invest pretty heavily in.

>> Adrien Auclert: Well, I think we could talk about the calibration in a little bit. The calibration is pretty realistic. So we have multiple capacities to consume that are $0.25 on the dollar at a quarterly level.

That's typically what estimates of the effects of fiscal transfers are. So given this, even with homothetic demand, you're right that the rich consume more energy in the model and they have lower marginal populations to consume. But there's still a big effect from. The key for us is to make the negative effect on demand from rising energy prices, declining real incomes overwhelm the substitution effect.

So it's a race between those two. And because we think it's realistic to assume relatively low elasticity as a substitution, in the short run that effect ends up dominating.

>> Speaker 6: So there's a paper by Garud Nachenko and I can't remember his co author. So it was at EFG a few years ago.

Arlene Wong discussed it. It was directly about like how, what happens when, when gasoline prices go up, what happens to expenditures using like credit card data. So you could estimate whether the CS 50 is greater than one, whether what it looks like for different types of consumers and things like that.

They might have that paper.

>> Adrien Auclert: I only vaguely remember that paper. I don't, but I think I've seen it, but we don't have it in our references.

>> Speaker 6: So thanks, that's very useful.

>> Speaker 3: You have energy taxes in the baseline and if so, isn't the policy simply to adjust those?

 

>> Adrien Auclert: Okay, so let me talk about fiscal policy. So that's great. This is our next step. So we're going to consider various types of fiscal policies. So this is a heterogeneous agent model. So we can think about fiscal policies that are either directly affecting energy prices, so say subsidies to the energy price.

Or we can think about fiscal transfers that could be targeted to different types of agents. And so in a baseline, we'll find that, in fact, for a small open economy, energy subsidies can be very effective at mitigating the real income decline. In an extreme scenario where government pays for the entire energy increase or say, fixes the price of energy, that's great for a small open economy.

But the problem with that is that it doesn't affect the source of the issue, which is that demand is too high, actually, if you do this for the world as a whole. So if you imagine that there's coordinated energy subsidies everywhere, actually the price mechanism no longer works.

So the only way in which you end up clearing the market is at extremely high energy, world energy prices. So we'll talk about that. That even though energy subsidies seem like a silver bullet for small economies because they end up fueling energy demand, they can't work for the world as a whole.

 

>> Speaker 5: And they also reduce the elasticity as perceived by the.

>> Adrien Auclert: Absolutely, yeah so in the extreme case.

>> Speaker 5: Completely perverse idea.

>> Speaker 6: Yeah, you'd want to do the opposite, right? You want to raise taxes, increase the elasticity, lower the average markup. Is that gonna be in your calculation at all about fiscal policy?

Like the secular using energy, cyclical energy taxes to reduce the markup of the energy exporters?

>> Adrien Auclert: So we're not going to think about the markup of the energy exporter facing this quite inelastic demand for energy in the first place. So we're not gonna address that. In an earlier paper, we had a model where the elasticity substitution could be quite low in the short run, but ends up being quite big in the long run.

So if you're thinking about why is it that the markups aren't enormous in the oil market? Maybe that would be one of the reasons, so here I'll have a very reduced form modeling of the supply side. So the rest of the world is going to be just undoubted with this energy.

So we won't think about the markup, but.

>> Speaker 6: It could be for Bob's reason that what's optimal from a private point, well, from a cyclical point of view, is not from a secular point of view of its impact on the average market.

>> Adrien Auclert: Yeah, and relatedly, I think there's this time dimension in the elasticity substitution.

So the average markup may be more related to the long run elasticity than the short run elasticity. Maybe, but I think that's a super interesting.

>> Speaker 7: My economics education goes back to the 70s, and the equation was MV = PQ was popular. And so I remembered some arguments about how when, let's say, the price of energy goes up, let's say because of foreign increase in price, that the Fed should accommodate that by printing money.

Because the thing is that this is gonna raise the demand for money. And if you don't accommodate it, then you're gonna try to force the real price, the nominal price of other things, to go down, which because of stickiness is not a good idea. Now, is that involved?

Is that anywhere here, or has that been totally dismissed?

>> Adrien Auclert: Well, so in this context, the Gallimo naturally model that we build on actually makes a big distinction between the consumer price index and the producer price index. Which is the one that's sticky in domestic prices and so that's the one that the Fed would want to stabilize.

So in a sense. So this Gallimonacelli model, it actually predicts that you want to completely accommodate any movements in exchange rates. Or other things that are moving import prices because those can be flexible prices. And the source of the nominal rigidity is the kind of the problem that the Fed is facing is actually on domestic prices.

And so this equation that you talked about just wouldn't work or it would only be applying to domestic consumer prices.

>> Speaker 7: What's happened to the demand for money? That's now domestic versus consumers versus business, I don't know. Both demand money. That's the issue is what is the demand?

What happens to the demand for money?

>> Adrien Auclert: Yeah, so this is a model which doesn't think about the demand for money per se, right.

>> Speaker 7: It's monetary policy without a demand for money.

>> Adrien Auclert: We're just going to be thinking about interest rates or the fed demanding interest rates directly.

We can think about money demand. But again, I think that you'd really need to think about what's the demand for real money balances. Is this influenced by the consumer price index or is this influenced by, say, the producer price index or what goes into the demand for money?

And so we're not getting into that at all.

>> Speaker 7: This has always puzzled me about how you can have a monetary theory when there's no money in your models.

>> Speaker 5: Well, he has interest rates.

>> Adrien Auclert: Yeah, the interest rates, there's price stickiness, and so that's it. We're in business, happy to talk more about this.

 

>> Speaker 5: This is just a non-issue that you can just take the kind of situation you're talking about, and then it becomes just a separate add-on to the model.

>> Adrien Auclert: Correct.

>> Speaker 5: And-

>> John: Yeah.

>> Speaker 5: And then this is one of the simplifications. But it's not an ignoring of the problem, it's just mapping it into another endogenous.

 

>> Speaker 7: I've always wondered, what are the assumptions that underlie the simplifications?

>> Adrien Auclert: We talk a little bit about this in my second year monetary economics class.

>> John: Have you ever looked at Woodford's? We should let anybody go?

>> Adrien Auclert: Yeah, so the first chapter of Woodford's textbook is useful, I think, to think about this.

So, but again, I'm not, you know, I'm not going to think about money demand at all. You can add money demand in the utility function, say, and then work out the implications for money. That's not the subject of today. Okay, so this is my plan. So I know this is a short talk, so I'll just outline the model.

And then I'll talk about why heterogeneous agents change our perspective on the effects that energy prices have on aggregate demand. Talk about implications for inflation and this possibility of a stagflationary situation, and then monetary and fiscal policies as ways to manage the energy shock. So this is going to be building on a completely standard model in open economy macro, which is the Gali-Monacelli model.

That's a model of a small open economy where countries are producing a good and importing a good. So there is a home good that they're producing and exporting, and then there's a foreign good that they're importing, that's the standard model. So to that model we will make one change, which is we're going to add one good, which is an energy good.

So we're going to say this energy good is a good that the rest of the world is endowed with. And then our small open economy, it's part of a continuum of energy importers. And I'm going to be thinking about this as a small economy first. And then when I talk about coordinated policies, I'll say what if this entire continuum of importers, they end up doing the same thing, say they raise monetary policy.

What happens? So there we'll have an effect on world energy demand. And the way households are modeled here is as consuming energy, right? So this is directly entering their consumption, so think oil that we're consuming directly. And there's a certain elasticity of substitution, which I'm going to call chi, between oil and consumption and other goods.

And because I want to isolate the effect on demand, I'm not going to have energy used in production. So production is going to be directly out of domestic labor. There's no energy used in production. We can talk about what happens if you add that back and then the energy is trading at a certain world price, p star.

And this is going to be what we shock, okay? So P star is the world price of energy, say the dollar price of energy. We're gonna shock that, and we're gonna think about the effects it has on the domestic economy, including on domestic energy prices and aggregate demand and so on.

 

>> Speaker 6: It doesn't matter from the small economy's point of view whether that price went up because say global e supply went down or the rest of the world's demand went up.

>> Adrien Auclert: Rest of the world demand would affect us? Yeah, so the way we'll think about it is because global E supply went down, that's how we'll microfound it.

And that will be important when we stop thinking about world equilibrium. If it was an increase in global demand and this would affect the demand for our exports, so this would have another effect. Right, yes, yeah, so that's why. Yes, you're right. The micro foundation, the way you want to think of it is there is a reduction in the supply of world energy.

 

>> Speaker 3: So far this looks like could be toys, it could be out of season fruits and vegetables, whatever, right?

>> Adrien Auclert: Absolutely, yeah, so this is just a good, an additional good. So you're saying what's special about energy here?

>> Speaker 3: I mean, you decided to write a whole paper about energy.

 

>> Adrien Auclert: Right.

>> Speaker 3: So you must have in mind it's not like out of season fruits and vegetables.

>> Adrien Auclert: So that's a good question. So I think food in this model, so a big increase in commodity prices of any kind would work through similar channels. So it's not specific about energy in that sense.

Now, the motivation is obviously thinking about the current European situation. And when is it that a shock to commodities, say, creates such a big effect on real incomes that it justifies large fiscal interventions, and, say, monetary policy intervention? So that's the sense in which maybe because the shock can be big when we're thinking about applying it to energy?

 

>> Speaker 3: The supply of oils may be less elastic than fruits and vegetables maybe, I don't know, certainly for it.

>> Adrien Auclert: That could be it too, yeah. So in our model, the supply is completely inelastic here. And then we're thinking about moving around demand through things like monetary policy.

So that's another issue-

>> Speaker 8: Inelastic supply?

>> John: No, no.

>> Adrien Auclert: Inelastic-

>> Speaker 8: Inelastic demand. Yeah, okay, he said supply.

>> John: Okay, well, we all caught that.

>> Speaker 3: I gave the example of food because that's also inelastic.

>> Adrien Auclert: Correct. Yes, yeah, yeah, yeah.

>> Speaker 3: But-

>> Adrien Auclert: So-

>> Speaker 3: Oils comes out of the ground and then toys come out of some Chinese factory.

 

>> Adrien Auclert: Mm-hm. So, there's more elastic supply, yeah.

>> Speaker 3: Price might not vary so much.

>> Speaker 5: The key issue is that there are bad guys who have a major role in oil supply, in particular-

>> Adrien Auclert: Quebec.

>> Speaker 8: Natural gas.

>> Speaker 5: So it's the bad guy part of it. Isn't that in the background here?

 

>> Adrien Auclert: So here, again, so there's an endowment of energy, and we're going to think of a shock as a shock that reduces the endowment. So we won't think about the supply side at all, right?

>> Speaker 5: It's a good idea to have a plausible story behind that.

>> Adrien Auclert: Right, so the story is, say, Russia invasion of Ukraine reduces the supply of gas to Europe, and so that part is simple.

And then to the question of what's special here, this elasticity of substitution hike could be anything in principle. But we're gonna be thinking of being low because we're thinking about something like energy, that's hard to substitute in the short term. And so that's another reason why it's a good model to think about energy.

But I agree with you, this level of abstraction, there's nothing very special about energy. It's more, I think, about the calibration. Make sense?

>> Speaker 5: You should be more aggressive.

>> Adrien Auclert: Okay.

>> Speaker 5: For a long time we've been caring about energy shocks for a good reason.

>> Adrien Auclert: Yeah, but I think one of the reasons is because they're so volatile.

Yeah, so-

>> Speaker 5: Yeah, you're right.

>> Adrien Auclert: Energy prices are so volatile. And so this is a topic that's been studied, to some extent, say, Olivia Blanchard has a number of papers on effects that energy shocks Have on aggregate in the context of new Keynesian models, but in his models, he has representative Asian model.

So the effect that everybody talks about, which is that these are big shocks, big declines in real incomes, and so they can affect demand. That effect is not there in those models, so that's one of the main points we have.

>> Steve: Let me ask a question. Is the European episode really about energy supply shock or reduction in the supply of natural gas, which in the short run isn't very easily substitutable with other forms of energy?

In that sense, this episode seems quite different from the oil price shocks of earlier decades that motivated much of the literature.

>> Adrien Auclert: It's true that in Europe at least, the substitutability problem is mostly for gas. So you can think about this model very narrowly applied to gas prices.

 

>> Steve: Okay, but then that's gonna inform when we get to the calibration exercise, what we think about the substitution elasticity, the share of household expenditures devoted to.

>> Adrien Auclert: So both the chi, which is elasticity of substitution, and then the share of energy in total expenditures.

>> Steve: Is that how you want me to be thinking about this model?

Then it's really a natural gas shock to Europe.

>> Adrien Auclert: Yeah, so here we'll.

>> Steve: Some parts of Europe, I guess.

>> Adrien Auclert: Yeah, so the calibration here is to, is energy share of total spending is 4%, so that's. That's a number that's between kind of gas and gas plus oil for households.

 

>> John: So Sebastian has a question. Sebastian, can you hear us? Sebastian? Okay, go ahead.

>> Sebastian: Yeah, this is very interesting, I'm not sure, since you guys are there in person, who is speaking, but I think it was Ken Judd who said, being trained in the 1970s. So I think from that perspective, a question is, how does this relate to the work of Mandel?

Immediately, it seems to me that this is very much along the lines of what Bob Mandel was doing. And in that regard, it seems to me that this falls within the general category of the transfer problem. We can think of this as a negative transfer that these small countries have to make.

And then the question is how to affect the transfer and the effect that that will have on ready prices and exchanges and so on, if everyone reacts in the same way. And of course, if we talk about Bob Mandel, the question of the optimal combination of fiscal and monetary policy comes very much into the game.

So I'm wondering whether there is any connection between Gali Monacelli, in some ways is not too distant from Mandel, in my view. So I think that that's, sorry for bringing more sort of history of thought, but I think that it is important.

>> Adrien Auclert: Thanks, so, I haven't read papers by Mandel that deal with this issue, and I'd love to read them, so if you can send them to me, that'd be great.

The shock is not like a transfer shock. And so it is a shock in the primitive shock, like Pete was saying, is a shock, it's a reduction in the endowment of energy for the rest of the world. And so that's raising prices for this domestic economy, and then we're dealing with that.

So it's different in that respect from the old transfer problem literature. But I haven't read the Mandel paper, so do send them to me, thanks. Okay, so the second modification we'll make to this Gali Monacelli model is that we'll have households that face borrowing constraints and idiosyncratic income risk.

And so the main effect of this, as we were talking about earlier, is that it generates these high marginal capacities to consume out of transfers. So, agents are close to a borrowing constraint, they're either at the constraint or very close to it. They have a big precautionary savings motive.

If you give them a transfer, it relaxes that motive, and so they'll spend a lot out of this. And so conversely, if you raise energy prices for them, they're consuming all their income, or close to all their income. And so they have to count on spending, so they have high marginal capacity to consume out of the rising energy prices.

And the final modification is that it's a model with the standard nominal wage rigidity, as opposed to price rigidities in the initial model, and will also allow for real wage stabilization motive. So if we want to think about stagflation. So why could it be that a rise in energy prices, so increasing the CPI, ends up raising domestic wages, will argue that something like a real wage stabilization motive is needed.

Otherwise you actually get wage deflation. And so if we want to think linking the rise in energy prices to an increase in wage inflation, we have to add something else.

>> Steve: I'm sorry, just what's a real wage stabilization motive? Other than just, people wanna get paid their marginal products.

 

>> Adrien Auclert: No, so you'll see how it enters in the equation. It's basically like they place extra weight on having stable real wages relative to a standard formulation, where they're equating the marginal rate of substitution between hours and consumption to the real wage.

>> Steve: That comes out of the model, the primitives, or that's just a tacked on assumption.

 

>> Adrien Auclert: That's going to be tacked on top, so that's the way that bunch did it. So you'll see in the standard, if you take a standard New Keynesian Phillips curve, and you ask, well, what's the effect of rising energy prices on wages? It'll actually predict wage deflation, because even though real wages are falling, hours are falling too, and they're falling by more.

So it's like a demand shock, and that effect overwhelms it, so wage deflation is actually the outcome. And so if we wanna think about wage inflation, which we're seeing as kind of the outcome of some bargaining problem where unions are bargaining for wages. You have to think that they care extra about real wages relative to the standard motive.

 

>> Steve: Okay? In the US, real wages have been falling. Is that not true in Europe?

>> Adrien Auclert: They have been falling. So real wages do fall, right, but there's wage inflation. So wages are not fully catching up with prices, but they are not falling, nominal wages are not falling.

 

>> Steve: Okay, maybe I'll come back.

>> Adrien Auclert: Let's come back to it when we get to it, so let me just talk about demand first, and then we'll talk about inflation and then I'll go until one, or we have.

>> John: Keep going, interacted a lot, yeah.

>> Adrien Auclert: Okay, all right, so we're gonna do a tentative calibration to a European country.

We'll shock this energy price, and I'm gonna consider the case with representative agent first and then with heterogeneous agents. And so here you have to make an assumption, as in any New Keynesian model, as to what monetary policy does. So we're gonna have a benign type of Taylor rule that just raises the nominal interest rate to stabilize the real interest rate in CPI terms.

So that's just to establish a benchmark, and then we'll talk about what happens if monetary policy tightens by more or accommodates the shock. And so in the representative New Keynesian model, you get this boom. So this is a representative new Keynasian model with complete markets in Garimo and Sheri.

So there is a real income decline from the rise in energy prices, but that's insured by the rest of the world. Monetary policy here stabilize the real interest rate, so actually consumption doesn't change. The level of consumption is unchanged, but what happens is that you direct your consumption more towards domestic services that are produced domestically away from energy prices that are imported.

So actually that raises GDP, so that raises GDP, that raises hours, and so this is what you see in the left graph, and this effect increases with chi, this elasticity of substitution. So chi equals one is the collapse felt case where you have unitary elasticity of substitution, and so in this case this is 100% shock.

So you get a 6% effect on GDP because the share of energy in GDP is 6%,

>> John: What exactly is a shock here in this?

>> Adrien Auclert: So, here the shock here, because it's a small open economy, I can just shock directly the price. But the way to think about it is there is a shock, there is a primitive shock that reduces the supply of energy to the rest of the world, that's raising the price of energy, and then I'm working through the effects of the price.

But in a minute, I'm gonna come back to this and add back the micro foundations where it's declining the supply.

>> Speaker 7: Did you say something about something insured by the rest of the world?

>> Adrien Auclert: Yeah, so how do you want to think of this? I mean this is standard international risk sharing conditions, so in these models with complete markets, there's international risk sharing.

So these types of shocks are insured, so there's Biker Smith condition, and here the real exchange rate is stabilized, so consumption is stable. So that's, that's how these models work. I mean, you know, we couldn't question that assumption, so and I think, you know, we do question it.

You wanna do kind of a double deviation from this first, you wanna remove international risk sharing so that, so there you're in an incomplete market representative model. That model has low marginal prognostics to consume, and so that's not going to be enough to create a downward pressure on demand.

So in order to go further, you, you add the heterogeneous agents, so I'm just gonna go straight to that heterogeneous agent model. But you're right, the primitive reason why you don't get a recession here or you get any effect on consumption from the decline in real incomes is because of a re-sharing condition.

 

>> Speaker 8: The world planner would have people who make non energy goods work harder.

>> Adrien Auclert: That's right. Yeah, that's right. The world panel would do this. Yes, so-

>> Speaker 8: And that's the people who live in your country, they make non energy goods.

>> Adrien Auclert: They make energy goods and they work harder, yeah, yeah.

So we're, you know, so this is similar to the first best situation. Yeah, absolutely. Okay, so this is now the situation with hetero incisions, so here you have higher marginal basis to consume, and so you get a negative real income effect from the decline in real incomes. But of course, output here is endogenous, and any movement in output gets amplified with high marginal capacity to consume.

So if you think that there's a big domestic boom, say, because everybody's substituting with high elasticity as substitution towards domestic services, we're producing more services, then you might, then you still might get a boom. So the question is, what happens to real incomes overall? And so that turns out to be governed by this chi, so when chi equals one, in this case, we can prove this is similar to a well known result by Colin Hubsfeld that the heterogeneous agent and the representative agent model behave the same.

And so you actually, you get no effect on consumption and a rising output. But if you have lower elasticities than one, which we think is realistic to think about energy, then you get in a situation where consumption declines, so the, so the effect on output is not enough to overwhelm the real income decline.

And if the elasticity association is sufficiently small, actually output falls, so you see this on the left. So chi equals 0.1, you get a 6% decline in GDP now from the energy shock. Okay, so that's to show you why heterogeneous agents, with these high margin capacity to consume, combined with low elasticity, the substitution between energy and non energy, can create a situation where the energy price shock implies a decline in aggregate demand.

 

>> Speaker 5: What you've done here is recreate the implicit model that most people use to think about this topic in the seventies, because they would typically have a marginal propensity to consume of 0.7 or 0.8.

>> Adrien Auclert: Wow, that's high.

>> Speaker 5: Not 0.15.

>> Adrien Auclert: Right.

>> Speaker 5: So, you've done it.

 

>> Adrien Auclert: So, in many ways, you know, this, Hank, literature revives some old ideas about, you know, the can cross and so on that were in Ayas salam. But it gives them a modern flavor, so we can think about micro foundations, and we could think about, you know, optimal policy and so on.

So that's, that's new but, so some of these ideas are, I'm not saying we're not completely reinventing the wheel here. We're just giving a modern tack to some old ideas.

>> Speaker 5: Yeah, I just wonder if it really works but that's.

>> Adrien Auclert: Well, if it really works. Okay, what's your concern?

 

>> Speaker 5: Well, people like peace to ferry have, have shown that, that there's a lot of insurance that even relatively poor people get, but it's not traded on a market. It's their friends and relatives, so there's research showing what happens to the actual consumption of people who become unemployed, and it's way less than it ought to be.

 

>> Adrien Auclert: So there's a range of evidence on margin Pompes to consume blonde, del Pista, ferry and Preston, for instance, is kind of at the lower end of what the literature finds. If you're looking at, say, direct evidence from how people spend lotteries that seem to be on the higher end, then you might wonder, is the NPC the same out of an unexpected, completely unexpected winning lottery versus a usual income shock?

So there's all this debate.

>> Speaker 4: More of a common shock versus an idiosyncratic one. That seems like important distinction in this set. Most of the micro evidence is from idiosyncratic shocks.

>> Adrien Auclert: That's right.

>> Speaker 4: Those might be smooth more effectively than a common shock.

>> Adrien Auclert: Yeah so the calibration here is always, you know, so in the model we can think about what happens if you're on your own getting a transfer and nothing else changes.

So that's partial equilibrium effect, that's what we calibrate to literature from this literature from lotteries. So, but you know, you can, you can question exactly, you can recalibrate the model to hit different levels of marginal popacity, consume depending on what you think is the evidence. You know, one of the things I'll say is a very big difference between what we do in ISLM is that agents here respect budget constraints and so in particular marginal capacities to consume.

If you give agents a transfer, say they'll spend it at some point, and the question is when do they spend it? So do they spend it more now? If they're out of constraint, they spend all of it now or do they spend it later, and it's like what's the time horizon over which they're spending?

And so the question becomes more an intertemporal question than a static question, but otherwise some of the effects are similar.

>> John: Let me just interrupt, there's three people, the visible, because they have their screens on. There are another 30 who don't have their screens on, so they might want to ask questions, feel free to any of you to ask questions if you have them.

I'm sorry.

>> Adrien Auclert: Absolutely yeah, yeah, yeah, yeah, I'm very happy to take questions from anyone.

>> John: Okay.

>> Adrien Auclert: Okay, thanks, so let me talk about implications for inflation since Steve brought this up. So we're gonna quantify this model by allowing for price nominal price stickiness, but also real wage stickiness.

So, what I mean by nominal price stickiness. So if you're looking at prices at the pump, say in Europe, and then you look at the oil price, there is some slow pass-through. And so in order to have a realistic quantification on the effects on inflation, we're gonna add nominal price rigidity.

So we'll have pricing to market. So we'll have some oil importers or some, say, gas importers that are paying marginal costs. But they're paying the oil price on the market, but then their domestic price is sticky, so they only pass it through to consumers over time. So that's relatively standard sort of muting the effect that the energy price that the source has on consumer prices.

But the key that we'll find for thinking about, in a causal way, of thinking about the effect that the energy price shock might have on wages is to add a real wage stabilization motive. So here, you can see, this is the standard Keynesian wage Philips curve. So, at any point in time, the real wage may differ from the marginal rate of substitution between hours and consumption.

But when there's pressure from the marginal rate is high relative to real wages, people ask for a nominal wage increase to try to bring back the real wage to the right level. And so that's just a slow process by which real wages adjust to marginal rates of substitution.

And so in the standard case, you'd have the zeta term be 0. So that's the standard new Keynesian Philips curve. So that's only nominal wage rigidity. And then if you start raising that zeta, you have an additional motive. So you care about real wages being stable over and above what would be implied by the standard equation, okay?

So if I start from the situation where zeta is 0, so this is just nominal rigidity, then the energy price shock in this situation where QAl is low is just a pure negative domestic demand shock. So it creates a decline in domestic output. Nominal wages actually decline and then there is some positive effect on CPI inflation from the imported inflation, right?

But here, in this calibration, nominal wages declined by 10%, so the CPI inflation that you get is negative. So you actually get deflation here just because of this big downward pressure on wages. So of course, real wages are declining, but as we said, the thing that overwhelms it is the fact that hours are declining.

So actually households feel like they're not working enough, and they're asking for wage cuts. And this effect kind of goes away as you start pushing up on this data. And this is something that Blanchard and Ghali had argued in earlier papers is also useful to think about this wage-price spiral.

So now, if you start pushing up on zeta, you can get the situation to be a stagflationary-type situation. So wage setters are averse to seeing their real wages declining, so they ask for bigger increases in nominal wages. At some point you get positive wage inflation and the real wage doesn't decline by as much.

And so of course, because you get positive wage inflation, you also get even more price inflation because now you get both the imported inflation and the domestic wage inflation. Okay, so we think maybe this is important today to think about what's going on. And when people are asking for wage increases, are they focusing too much, in a sense, on consumer prices?

This model suggests that consumer prices isn't the right thing in the face of these shocks. Actually, people should care more about their wage relative to, say, the prices of domestically produced goods. So we think of this more as a hypothesis. That's interesting to think about the situation. And so we'll go with this calibration to think about monetary and fiscal policy.

But, I don't wanna say we've nailed this parameter. We just think it's interesting because standard models would actually predict deflation in response to these shocks. Okay, so let me talk about monetary and fiscal policy. So, we're gonna think about three scenarios for monetary policy. So as I said, there's a Taylor rule here.

Monetary policy sees price inflation and then it raises nominal interest rates in order to stabilize the real interest rate. So that's the blue line. And then we're gonna think about what happens if you tighten by more or you ease. So what happens to adcoms? Okay, so to think about the impact this has on real interest rates, this would be say to raise the real interest rate by 2% on impact, or easing would be -2%.

Okay, so, of course, a tight monetary policy causes a deeper recession. So this is kind of as you'd expect. So if you raise interest rates by even more, you lower output. So here the output decline goes from 2% to 4%. But the other effect you have is you appreciate your real exchange rate.

And so as you tighten, you're able to appreciate the real exchange rate. And so that could be a solution to the imported inflation because now the domestic price of energy falls. So we can assess how big that effect is. And the answer is not that big, because standard calibration of the effects of monetary policy on exchange rates suggests that you can only really appreciate the exchange rate so much without collapsing output, okay?

So, if you want to really mitigate the effect that the oil price shock at the source, the dollar price, price of oil has on domestic consumer prices, you really have to appreciate your exchange rate, and you can't do this without a big recession. So in this calibration here, you see on the left, this is the path of domestic energy prices.

You have almost no effect on this with your monetary policy. So, monetary policy is just not able to affect the domestic energy price that much.

>> John: It seems like a small change in monetary policy, though.

>> Adrien Auclert: So 2%, yeah, if you're thinking about, I mean, the baseline level is like a 6% increase in the nominal interest rate to begin with, and we're going from 6 to 8.

So it's not trivial, but yeah, so if you're thinking about this bad, the additional effects, like I said, it's easier to think about it in terms of the real interest rate. So if you have a 2% effect on the real interest rate for two quarters, UIp type calculation suggests that's a very small effect on the real exchange rate.

 

>> John: Okay.

>> Adrien Auclert: And so it's a small effect on the domestic price of energy.

>> John: There's a question from, it was Chris. Chris?

>> Chris: Question on clarification. So, these experiments consider easier or tidier policy for one small country, but if everybody pursued a much tighter policy, it'd have large endogenous effects on the oil price, presumably.

 

>> Adrien Auclert: Great, okay. Yeah. Thanks, Chris. Yeah, that's exactly my next point. Okay, so, thank you. So, yeah, so my next point is exactly this, that we've just considered one country in isolation. So the country, by definition, it's small. No matter what you do, and no matter how, say, you reduce your demand domestically, that's not affecting the world demand for energy.

Okay, so what happens now if, like, all countries tighten together? So this is where we go back to the micro foundation. So this was Pete's question. So, initially, I said, well, the shock is just a shock to the price, but the way we wanna think about this is actually what's happening is that That there's a demand curve for energy, and then the original shock is a reduction in the supply of energy.

You see this here, right? So it achieves a certain increase in the energy price. But now we're gonna wanna think about exactly, well, we're gonna calibrate the model such that the decline in the endowment for the world gives us the increase in the energy price that we see.

And then we said, well, what happens if all countries are tightening monetary policy together? So in that case, they are affecting the demand for energy. So this is the situation you see over here where now you're shifting in the world energy demand curve because all monetary policies are acting together.

And so you are able to affect, this is the dollar price of oil, you see? So you do increase the price of oil, but by not as much. So when all countries are acting together, you can reduce the source of the problem, which is that demand is too high relative to supply by contracting demand, okay?

 

>> John: So these are numbers?

>> Adrien Auclert: So here, this is just an illustrative graph, but yeah, so the numbers are coming from the model. So we are using the model to back out how much of a decline in supply do you need to get 100% increase in the energy price?

And then we say, okay, in that model, now let's use the endogenous decline in demand that comes from the monetary policy, contracting demand for all goods, including energy goods, in order to figure out what's the endogenous price of energy in the model. So this is exactly Chris's question.

Okay, so there you, so you see, you are in this positive spillover type situation, if all monetary policies are tightening at the same time, you're bringing down the price for everybody else. And so it's like a coordination problem for monetary policies. So where if everybody tightens, you're able to reduce the energy price.

And so you see this now to the panel on the left, so this is the path of the world energy price. Everybody contracting together has just better outcomes. And there's also a free rider problem, you want the fed to tighten in order to reduce US demand for energy so that you don't have to tighten as much.

So that's on monetary policy.

>> John: Is one of these optimal?

>> Adrien Auclert: Okay, so optimal is something that we're working on, but we're not there yet. So it's actually optimal policy with heteronormal agents is really complicated. There's lots of different motives, including planner trying to get around borrowing constraints and so on.

And so we're not at the level, I can't give you the answer yet, but we're working on it.

>> Speaker 3: Even the definition of optimal, it sounds like you're talking from the point of view of the importers.

>> Adrien Auclert: Right, optimal from the perspective of the planner, yeah, exactly, the small open economy planner.

 

>> Speaker 3: What about the importers, not the worldwide planner.

>> Adrien Auclert: Not the worldwide planner, yeah.

>> Speaker 3: So then, I mean you're trying to screw OPEC.

>> Adrien Auclert: So there's also that.

>> Speaker 3: Trying to do.

>> Adrien Auclert: Yeah, so that's always there. So you're a monopsonist and you're a monopolist. You're a monopolist cuz you're selling your own good to the rest of the world.

So you have this monopolist motive and you're also purchasing from OPEC and so you could try to act as coordinated buyer and so-

>> Speaker 3: The world planner would have us produce more. But now you've given us an opportunity to act as a monopolist in this non-energy good. So we're gonna grab that opportunity.

So we actually want output to go down.

>> Adrien Auclert: So that's right, for the good that you're producing, that's right. And then at the same time you're coordinated all the buyers, so you have like a monopsony issue.

>> Speaker 3: We should be doing that even without an oil shock, right?

 

>> Adrien Auclert: That's right. So that effect is already there in the optimal policy literature for representative agents. So the effect of the monopolist effect, that's kind of a well known effect. The monopsonist is more interesting, I think, and so that's something that we haven't explored. But because we were working with these heterogenous models, like I said, there is like all these other effects.

So it's like, what's the optimal level of public debt in the economy? So all these questions are-

>> Speaker 3: From my point of view, this is disaster. I mean, you have OPEC holding back and then we respond, we're gonna hold back our demand and we're gonna hold back our supply.

I mean, that's wedges on top of wedges from a worldwide point of view.

>> Adrien Auclert: Yes, yeah, no, I agree. I mean, or you might say, what if it's like the world planner that tries to reduce wages for the world as a whole?

>> Speaker 3: Can we think of a better way to fight with each other?

 

>> Speaker 5: You have to figure out the preferences of this planner.

>> Adrien Auclert: Yeah, so if the planner just cares about domestic welfare, then Casey's point is right. Yeah, so there's-

>> Speaker 5: Your assumption is that, right? Why not have a single god who has preferences defined over everyone on earth, other planets as well.

 

>> Adrien Auclert: So here there would be three types of planners. So what we're seeing here is that there's this coordination issue for all, even these small open economies. So you might be thinking about say the coalition of all buyers of oil and so what would their optimal policy be?

And then you can think about a planner that cares about the entire world population, and including the suppliers and the purchasers of oil.

>> Speaker 5: There's a big issue then about people unborn.

>> Adrien Auclert: That's right, yes.

>> Speaker 5: Multiple dimensions here.

>> Adrien Auclert: That's why optimal policy is so hard, so we're working on it.

 

>> Speaker 5: So ambiguous.

>> Adrien Auclert: It's also ambiguous, but I think one of the benefits, you were talking about benefits of micro foundation earlier. I think one of the benefits is you can stop thinking coherently about optimal policy, but maybe you're also dissatisfied with some of the micro foundations. And so my perspective is there's already so much we don't know about the positive, so let's work on that first, and then we could talk about the normative and whether we think they're reasonable or the predictions are reasonable.

Okay, so this was monetary policy coordination, so my final topic is on Fiscal Policy. So here one of the benefits of working with these heterogeneous Asian models is you have very rich types of fiscal policies. And so we're gonna be thinking about three types of policies. One is just a direct price subsidy.

So this is the government just fixing say the price of oil or subsidizing the price of oil and then borrowing in order to pay for these subsidies. Targeted transfers, so by targeted transfers I mean based on your usual level of consumption, so those are actually regressive transfers. So they're transfers that because the rich here in this model consume more energy.

If you're giving transfers that are based on your usual level of consumption, you're actually giving transfers to the rich. Those effects are going to be less effective at stabilizing demand because the rich have lower marginal propensity to consume. Or we could do untargeted transfers like blanket checks, that's what the French government has just switched recently from a price subsidy to an untargeted transfer where it's just giving €100 to everybody.

And then they're all deficit finance initially, and then over time we're stabilizing our debt level by raising income taxes over a long horizon. So that's how we finance them in a short run, all deficit financing. Okay, so these lines show you that all these policies are effectively mitigating the conception decline in a small open economy because they are basically addressing the demand problem.

So they're all pushing up on demand. And so the conception decline gets mitigated, and of course, the untargeted transfer here, that's the most effective That's for a given level of effect on, say, the fiscal deficit. That's the one that gives you the biggest effect on demand because it targets the higher marginal capacity to consume agents more.

And those transfer programs are inflationary, but the subsidy seems like a silver bullet. So the transfer programs are inflationary for the usual reason that you're just fueling demand. But the subsidy, it directly affects the price of energy. So in the extreme, when you're fixing the price of energy, of course, you're just not affecting CPI at all.

And so that seems like a silver bullet. And of course, what's the catch here? And so this is just inequality. The catch here is, of course, well, then it's fine if you're a small open economy, because even though you're fueling demand or you're making demand more inelastic, it's just for your country.

So you can still rely on what's happening in other countries. But if everybody does this, the demand becomes extremely inelastic for the world as a whole. And so you have these huge negative externalities. So this is kind of the way to think about this, is it's pivoting the demand curve.

It's making demand much more inelastic. So now we were having an intersection over here, and then now the intersection is going to be through the roof. So the only way in which you can clear the world market for energy where everybody's giving subsidies is by having a very, very big world recession that's bringing demand back in line with supply right?

And so you see this in these graphs, where the subsidy situation is actually much worse than anything else. It's worse than the baseline, and it comes with enormous price inflation. Okay, so one of the things you can do in these heterogeneous agent models is ask, well, what's the effect on various measures of inequality?

This is one measure of the variance of log consumption. And even though the transfer programs on their own, in a small open economy, were effective at reducing inequality, all these benefits are gone when you're subsidizing energy. Okay, so that's my time. So we're using an open economy heterogeneous agent models to speak to this current energy price shock.

And we've argued that with these heterogeneous agent models, together with low elasticity substitution, you can get a situation where you get a negative demand shock. And then if you have, in addition to this, these real world wage concerns, you can get a stagflationary shock out of the initial energy price increase, Steve.

 

>> Steve: Maybe you'll persuade me otherwise. This doesn't seem like an apt application of the current situation in Europe.

>> Adrien Auclert: Okay.

>> Steve: And again, I may have the facts wrong. The restriction in natural gas supplies were the big issue. One of the most sensible things the Germans did. It's not even in your policy list, which is they built new LNG terminals.

Okay, so I guess you can think about that as well.

>> Adrien Auclert: You're moving E back up. So, basically, you're saying, I'm concerned about this. So now I'm actually going to address the supply, and so I'll-

>> John: Cancel the shock.

>> Adrien Auclert: Cancel the shock.

>> Steve: You're canceling the shock, but it points out also the shocks, it's not really a global shock.

This is not like OPEC in 73, 74, or however you want to think about the earlier, those were really global shocks. This was a shock to the supply of natural gas to a few countries in Europe for which it was hard to substitute to other forms of energy quickly.

 

>> Adrien Auclert: Right.

>> Steve: And one way was to import more LNG. So that seems like a very sensible policy response. Another way is you could try to make your household or your production sector less reliant on natural gas and substitute towards other forms of energy. That's obviously something harder to do in the short term.

 

>> Adrien Auclert: Right, so-

>> Steve: Those seem like the central policy questions, not what you're gonna do with fiscal and monetary policy.

>> Adrien Auclert: I mean, in practice, we saw France, Germany, they did try to increase their supply.

>> Steve: France tried to increase their supply of nuclear power.

>> Adrien Auclert: And they think of this as something that's helpful for maybe the medium term, a year or two years time.

But at the same time, they also gave all these really big energy subsidies. And so France had massive energy subsidies both for your energy bill directly and gas prices at the pump.

>> Steve: Okay, yeah, they hit those- These are big shocks, and I- And that they did those things, it's not clear whether they were helpful, or optimal.

But your framing of this as a world energy supply shock doesn't seem to fit the European situation. And one that frames it more, a model that's more focused on the natural gas restrictions. And the substitution possibilities in the short, medium term for natural gas would seem more useful.

 

>> Adrien Auclert: Right, so we could lower the energy share in consumption. And lower the elasticity of substitution in the calibration and say this is a model of gas.

>> Steve: Maybe it would have smaller effects in your current framework, as I understand it.

>> Adrien Auclert: The effects would be smaller, because the share would be smaller.

But because we could also plausibly lower the elasticity substitution, you know that. So lower elasticity substitution magnify this effect, so we might end up not so far. But that's a good framing suggestion, I'm not-

>> Speaker 5: Your whole investment and modeling is still applicable to Steve's fact situation, right?

 

>> Adrien Auclert: So here, we are feeding in a relatively transitory shock to energy prices. So one way to think about this is that in the medium term, supply gets back on stream because we're building more energy terminals. We're figuring out solution to the root of the problem, which is this reduction in the supply.

But in the short term, we have to deal with these really large energy prices and the consequences they have, including for demand for domestic goods, and so that's-

>> Steve: Again, my factual understanding here is pretty limited. But my understanding, correct me if I'm wrong, some parts of the economy, even some parts of Germany, are gonna be much more heavily exposed to restrictions of natural gas than others.

So that's kind of missing from this, too. So you think, even with these fiscal instruments, there'd be a spatially dependent aspect of them that would be quite important.

>> Adrien Auclert: That would be interesting to model, yeah. So the best thing I can offer now is, you can take this model in isolation to think about different countries that have different energy shares or that are facing different energy shocks.

And there isn't necessarily a big interconnectedness dimension, except maybe in these models through demand. So if you think that, say, demand for imports from Germany are going down, maybe that's affecting France, and so we would be able to build that.

>> Steve: Germany's decision to build LNG terminals was good for Germany.

It's probably good for the rest of Europe, too, right?

>> Adrien Auclert: Right, so that's feasible, so meaning, having granular countries where you say you can consider all the European countries and you say different countries are facing different shocks. And so how do you think about a realistic calibration to what's happening to different countries.

And spillovers where some countries are affecting other countries both by a common monetary policy and also via demand, that's possible to do. Yeah, thanks.

>> John: Chris?

>> Adrien Auclert: Chris?

>> John: Anybody else should jump in.

>> Chris: Really fascinating presentation. And I think one upshot is that monetary policy looks unattractive from the standpoint of an individual country because the trade-offs are very dire between reducing inflation and unemployment.

Yet from a global perspective, it's very desirable. Then on the flip side, subsidies look very attractive from the perspective of an individual country, but they're disastrous from a global perspective. So I think that's really a fascinating implication. I did have one question just on transmission to inflation, and in particular your zeta parameter, I think it is, that controls the pass through.

Now, that seems like it's really a big open question, is how much energy supply shocks transmit to inflation and how persistent those effects are. At least the empirical literature suggests that in the last 20 or 30 years, the effects on core inflation are really quite muted and not very persistent.

But so I was wondering how you chose that parameter. Certainly Blanchard and Gali are arguing that real wage rigidities have declined a lot in the great moderation period.

>> Adrien Auclert: Yeah, so thanks a lot, Chris. So you recognize the wage Phillips curve, of course, cuz we took it from you.

And the zeta here, to be honest, we just don't have a really good way to discipline it. So we actually took Blanchard and Gali's numbers from the 2000s. Here, we just did an exercise where we thought, okay, well, how big does this number need to be in order to actually get some wage inflation at all?

And then we compared to the numbers that they had in that paper. I agree, to us, it's not even clear that this is the right way to model it, in a sense. It's a little bit reduced form, it gets the job done. But I think, digging deeper, one of my views of the very big open questions in monetary policy today is, what's a good micro foundation for the wage Phillips curve?

And we're seeing all sorts of effects right now on wages at different points in the income distribution. And these kinds of standard models can't really quite get at this. So it looks like there's kind of an inequality compression effect that wage increases are having right now. That's not something that this type of model predicts.

So I think it's a really big open question. And the direction for this paper would be try to get a better way of calibrating the zeta. But more generally, I think just getting a better micro foundation for the wage Philips curve is good, important work.

>> John: So let me ask a question about this next to last conclusion.

Monetary tightening alone does little, but has positive externalities. Does that mean, in retrospect, we should have all done this together? Shouldn't just been the Fed? Is there any way you can relate this to current events Europe was behind, whatever you want to say is helpful.

>> Adrien Auclert: So there was a delay in monetary policy tightening in many countries, and the Fed ended up acting kind of earlier than others.

Now we're seeing the ECB and so on respond. I don't know the extent to which these types of considerations were the reason for the delay, say, in Europe. Certainly, they were looking for symptoms of inflation and the inflation was taking a while to pick up in Europe. So they might have just been reacting more to the direct inflation situation.

I don't think that those types of considerations were taken into account, these spillovers that, say, Fed tightening has on, say, the, the US demand for energy. But this framework suggests that this is something that countries need to think about. And I don't think that there's so many kind of frameworks to think about kind of monetary policy coordination, the benefits of monetary policy coordination.

And so this provides one reason. I don't want to say this is the main one or the only one, but I think it's certainly an interesting one.

>> Speaker 8: But when the energy shocks happen, the IEA, International Energy Agency by a representative, that's their job. Came out with a lot of lists of things that Europe should do to respond to the energy shocks, energy efficiency measures, fuel switching, stuff like that, all pretty sensible, but there's no monetary policy element in there.

But you could argue that had they come out with a recommendation, hey, everyone should think about this in terms of their interest rates and the kind of collective effect it would have. If we all work together, that could be constructive. I still don't think their mind is anywhere near that, how they view the problem.

So these were helpful thing for them to have in mind.

>> Adrien Auclert: Great, yeah, well, hopefully-

>> Speaker 3: Actually, I was thinking along those lines, but the basic economics is you're trying to do that monopsony, monopoly thing against, I said OPEC, I guess you really mean Putin in this episode.

But we had sanctions and things like that. So, number one, those seem more direct. But even if they're not more direct and you want to do this stuff, you still have to recognize that those are happening, right? You don't want to overshoot.

>> Adrien Auclert: Right.

>> Speaker 3: So there's an optional amount of withholding our demand and supply.

And if that amount's x, we don't wanna do 2x, because the Treasury Department's doing one and the Fed's doing x.

>> Adrien Auclert: Yeah, so here we study monetary and fiscal policy in isolation. But of course, you can kind of study them together, and so that's actually-

>> Speaker 3: And the sanctions, I don't know what bucket you put that in, but those were-

 

>> Adrien Auclert: Yeah, the sanctions are outside-

>> Speaker 3: We're agreeing not to sell things to Putin. Which is kind of, you like that in your framework, right?

>> Adrien Auclert: We like what, sorry?

>> Speaker 3: In your framework, you like that we don't sell things. I mean, you're making people unemployed-

>> Adrien Auclert: Yeah, so we want to withhold-

 

>> Speaker 3: Channels, but-

>> Adrien Auclert: Right, yeah, so at least the steady state of this model. Yeah, you want to withhold, you want to just act as a regular monopolist of the good that you're selling. Reducing the quantity produced in order to raise the price. So that's, for sure, is something that these countries want to do.

Again, here we're taking this positive perspective. So we're saying whatever is the reason why the markup is what it is, what happens if there is a shock around that initial situation. So we don't think about the optimal policy. But the optimal policy is a super fascinating thing to think about.

Outside the scope of this paper, more directly related to your question on what can we do in this paper, we can study together monetary and fiscal policy coordination and given that you're doing one, how much less do you want to do of the other? So that's something we can do.

Sanctions are a bit hard to think about in this context, except to the extent that they change the fundamentals, they change the shock. But they'd be harder to build in directly, I think.

>> John: Did you say something, you mentioned the heterogeneous agent quite a bit and a little bit without it.

How do these questions address differently because of the heterogeneous agent assumption you have? What difference does it really make?

>> Adrien Auclert: So the main thing, it's something I was telling Bob about, is marginal capacities to consume are higher. But you don't want to really think of them so much as the impact of marginal capacities to consume.

But what we've called in our other work these intertemporal marginal propensities to consume. So what you want to think about is, if I give an agent in this model $100, we know they'll spend $100 at some point. Because they are obeying an intertemporal budget constraint. The question is, when do they spend it?

So here in this figure, I've just shown you what happens in an incomplete market representative agent model relative to these heterogenous agent models. And so, in the incomplete market representative agent models, like the permanent income hypothesis. So if you give them a transfer, they basically just raise consumption forever.

They take the transfer, put it in the bank, eat the interest income. In a heterogeneous agent models, it looks more like this. So this is giving transfers to agents at different points in time, so on impact. So here this is calibrated annually to marginal propensity to consume of 0.5.

And then they keep spending at elevated pace for a while. And so you get these kind of prolonged effects on spending. And also there's anticipations of future transfers. So these other tents are what happens if I give transfers in five years, ten years and so on. I promise to give those transfers.

Some agents are not borrowing-constrained, so they're able to anticipate some of that spending. And so now we're moving the question to kind of a static what happens when people spend. And then that spending becomes income to this intertemporal dimension. What happens when agents obey budget constraints, but they have preference for spending at different points in time.

And so I'd say, in our work, that's kind of what we found is one of the major differences between these heterogeneous agents models and the older class of representative agent models, or like even IS-LM type static models.

>> John: Okay, any other questions, comments? Thank you, Adrien.

>> Adrien Auclert: Thanks a lot.